 Income tax 2023-2024, self-employment tax, otherwise known as SE tax. Get ready and some coffee, because tax season is when we test out our math skills. Question our life choices. Most of this information can be found in Publication 334, Tax Guide for Small Business for In- First, a word from our sponsor. Yeah, actually we're sponsoring ourselves on this one, because apparently the merchandisers, they don't want to be seen with us. But that's okay whatever, because our merchandise is better than their stupid stuff anyways. Like our, trust me, I'm an accountant product line. Yeah, it's paramount that you let people know that you're an accountant. Because apparently we're among the only ones equipped with the number crunching skills to answer society's current deep complex and nuanced questions. Looking at the individual income tax formula, remember in the first half of the income tax formula is basically a funny income statement. Most income statements having income minus expenses resulting in net income, here having income minus various deductions resulting in taxable income. The schedule C then rolling into line one of our income tax formula, which is a little confusing considering the schedule C itself is basically an income statement. Having business income minus business expenses, otherwise known as business deductions resulting in net business income from the schedule C that rolls into line one income of our individual income tax formula. This is the first page of the form 1040 where ultimately the schedule C income will roll into line eight additional income from schedule one. This is the schedule one additional income and adjustments the schedule C income rolling into the additional income part line three business income or loss from the schedule C. This is the schedule C profit or loss from business having mainly two main parts income minus expenses looking like an income statement. We're now concerned with the self employment tax otherwise known as SE tax noting that when we think about income when we think about taxes for the federal government, the primary way we fund the federal government to pay for things we need such as military and what not protecting us is through the income tax. But there are other taxes as well, which we often label under the term of payroll taxes, the social security and Medicare taxes. But if we're a sole proprietor, then we are going to have to be responsible not only for the federal income tax, but for what would be the payroll taxes, the social security and Medicare taxes. This is crucially important because many people overlook this when they move from a W to employee situation to a sole proprietorship situation in part, because although in a W to situation there's withholdings and payments of the social security and Medicare as well as the federal income taxes, and it is reported to us on pay stubs as employees and with the form of a W to reported to us and the government. When we do our form 1040 income tax return, those calculations for social security and Medicare don't usually have a big impact. So we're usually looking for a refund, hopefully, which is a focus on the federal income taxes. But when we're on a schedule C and have to calculate our own payments and our own taxes, then the self employment tax, which is kind of like the sole proprietor equivalent of payroll taxes, social security and Medicare is huge that we have to kind of keep in mind. Okay, so self employment tax is a social security and Medicare tax primary for individuals who work for themselves. Those that report say on a schedule C, for example, and you also have some complications in terms of other types of business entities to determine how self employment, social security and Medicare will be reported. For example, flow through entities like an S corporation partnership and an LLC, how are the payroll taxes, how are social security and Medicare going to be reported. We here focus mainly on a schedule C. It is similar to the social security and Medicare from taxes withheld from pay of most wage earners. Now, it's useful to kind of think of the comparison because lawmakers, the legislation when they're making the law often kind of forget about the sole proprietors as they focus on the large corporations. And then they have to kind of mirror the sole proprietors to what they decided for the corporations. Therefore, it's useful for us to think about the comparison of a C corporation, a separate legal entity, how they deal with social security and Medicare and how a sole proprietor does deal with social security and Medicare because that can help us to understand the rationale of what is going on. So note, with a C corporation, it's a separate legal entity, which means it's going to pay federal income taxes on the corporate level as a C corporation. It's owned by shareholders, everybody that works within the C corporation up to the highest executives, the CEOs and so on and so forth, are going to be employees. So they're going to be getting W2s, which will then have the payroll calculations withholding things like the payroll taxes, social security and Medicare and paying the employer part of payroll taxes on the corporation's side. So how does that match what happens on a schedule C? On a schedule C, we might not even have any employees. Imagine the simplest situation where you don't have employees, you could have employees for a schedule C, but let's imagine that we don't. Well, then we're going to have an income statement that is income minus expenses results in the net income and that's going to be reported on our form 1040. The IRS is going to say, hey, wait a second, we would like someone to be paying social security and Medicare in that situation. So then what are we going to do? What do you want me to do? Because I'm not a corporation. Do I have to actually pay myself wages? Because that's a pain to do. The IRS, in order to calculate payroll taxes, will know, typically the IRS is going to say, what I want to do is say that you are basically the employee of your sole proprietorship corporation and therefore we're just going to take the net income that you calculated on your schedule C and then calculate, in essence, payroll taxes on that net income. Not only that though, we're going to think of you as both the employee E and employer, so you're going to pay both, both halves of the tax on the net income that you earned. So that's going to be the general idea. You might say, hey, wait, there's net income in a corporation. What happens on the corporate side of things? Well, they do have net income. They have income minus the expenses. Part of those expenses are the wages and payroll taxes they pay even to their top executives and then the net income doesn't go to one person. It's part of the corporate earnings, which then will be distributed to the individuals and that distribution is called dividends. So then when the dividends happen, then you might have another income tax situation and that's why we get a double taxation with regards to income taxes because you get tax at the corporate level and then possibly on the distribution level, which is what is often trying to be avoided with some kind of flow through entities such as S corporations and LLCs. All right. That's the general outline. So caution, if you earned income as a statutory employee, you do not pay self employment tax on that income. Social security and Medicare taxes should have already been withheld from those earnings. So note that usually if you're an employee, you don't get to deduct things on the schedule C because the idea is that the employer is deducting those items and so on. But we saw that in some cases, for example, if you're a statutory employee, you might still have the schedule C and which case if you have the schedule C, you would think you would be calculating the self employment tax, but no, because you might still be having those paid through the employer in that special kind of situation. Social security coverage. Social security benefits are available to self employed persons just as they are to wage earners. Now, I just want to note the tone here that you're always going to hear whenever talking with the IRS. The IRS is going to take the standpoint of well, yeah, self employed people are paying into social security. That's a good thing. We're allowing them to pay into the social security. And why would they make that argument? Well, because by paying into social security, you're going to get the social security benefits at the point of retirement. Remembering that we in the United States have a question as to whether or not social security is like a federally funded like 401K plan, like a retirement plan that everybody should pay into and the government pays everybody out based on how much they put in. Or should we have something like a safety net program allowing people to say for their own retirement, but giving a safety net for those that can't say for retirement. So more and more social security has leaned towards like a federal funded, you know, 401K plan or something like that. And it's kind of going bankrupt. So most people I would think you wouldn't want to completely depend on if you don't have to social security as your sole source of income at the point of retirement. So obviously in practice, what we have to be thinking is practically in terms of there's two parts to social security. When we talk about social security, there's the amount that we have to put in when we're working. And there's the amount that we get back at the point of retirement. When we put the money in, the question is, is there any way we can avoid putting money in legally? If you can, I would say that's usually the good thing to do because then you can say for your own retirement much more efficiently than the government most likely. And then when you get the money out of retirement, the question is, do I have to include it in income paying income taxes on the benefits that we're going to be basically getting in retirement? So your payments of self employment tax contribute to your coverage under the Social Security Administration. So again, the argument from the IRS side is the more money you put in, the more you're going to get out of that beautiful like 401K type program or whatever. But obviously, again, it's kind of a mess because the more money you put in, it does increase the amount of benefits that you will get back. But the amount of increase in benefits goes down at a decreasing rate because they're also trying to use it as a safety net program to basically pay out larger amounts to lower income individuals. So that's why it's kind of a mess. So again, the idea would be, I would think, to try to save for your own retirement and reduce the amount you're putting into the Social Security and give it to other things if possible would be the general strategy usually. So Social Security coverage provides you with retirement benefits, disability benefits, survivor benefits, and hospital insurance benefits at quite a high cost. Because I could pay for those myself with all the money, I mean calculate all the money that's coming out of your wages at one of these days. Anyway, how to become insured under Social Security. So you must insure under Social Security system before you begin receiving Social Security benefits. So obviously the benefits happen at the point of retirement. How do you get the benefits? Well, you're going to be putting money in during working years. And again, it's kind of sounding like it's voluntary right now, but it's not voluntary. You mandatory put the money in and then you're going to get some benefits if you qualify for them at the point in time of retirement. So you are insured if you have required number of credits, also called quarters of coverage discussed next. So earning credits in 2023-2024. So for 2023, you receive one credit up to maximum of four credits for each $1,640, $1,730 for 2024 of income subject to Social Security tax therefore for 2023. If you had income self-employment wages of $6,560 that was subject to Social Security tax, you received four credits. Now this is getting a little bit wonky in terms of the calculations for Social Security. And again, from a simple standpoint, the simple strategy would most likely be, look, I'm going to try to pay as little into Social Security as I'm required to pay just like I would for federal income taxes. I'm going to pay the least that I'm obligated to pay under the law, even though in this case I'm going to get benefits based on the more I put in, because I'm of the standpoint that I would be better off putting my own money away for my own retirement and not relying on Social Security in part because we're really not fiscally sound from a federal standpoint and Social Security is a huge driving factor that's causing that problem. So if we don't redirect that ourselves, we're going to hit a wall at some point in time and whatever happens when that happens, you know, can't be good, right? Well, so I don't depend on the Social Security. But with these calculations, some tax planning strategies could come into play. We saw before that we might have a situation where we have a Schedule C and we might have like two people that are married, but the Schedule C is owned by one person. But maybe two people, if two people start working in the Schedule C, you might say, hey, look, one person wasn't making wages because they were a homemaker. Maybe if we were allowed to have them work for the business, they can put some money into Social Security so that we're still paying the Social Security on the income, but now because the Social Security is assigned to two different Social Security numbers, two different people, you might be able to get greater benefits at retirement. So that's the kind of planning that could come into place. Again, you have to be quite careful with that kind of planning, making sure that it's legitimate splitting of the profits and so on. So it's a legitimate strategy and so that you don't hit the cap. Because remember, if you make a high amount of income and you split the amount that goes to two people instead of one, then you might clear the cap ending up paying more money into Social Security, which I don't think might not be worth the added benefits that you're going to get from Social Security at the point of retirement. Okay, anyway, for an explanation of the number of credits you must have to be insured and the benefits available to you and your family under Social Security program, consult your nearest SSA office, Social Security Administration office. It's useful to note here as well that although these are both federal programs as opposed to state and their government programs, the IRS is different than the Social Security Administration. We're going to be reporting the calculation of our self-employment tax on the Form 1040, which we're basically sending to the IRS, but when we think about the benefits that we're going to be receiving, we're typically looking at the Social Security Administration, the SSA. So the SSA Social Security Administration time limit for posting self-employment income. Generally, the SSA Social Security Administration will give you credit only for self-employment income reported on a tax return filed within three years, three months and 15 days after the tax year you earned the income. So there's kind of like we might call a statute of limitations that's typically quite a long enough time because usually we file by April 15th following the year that we earned the income. So if you file your tax return or report a change in your self-employment income after this time limit, the SSA may change its record but only to remove or reduce the amount. The SSA will not change its records to increase your self-employment income. So who must pay self-employment tax? S-E tax. You must pay S-E tax and file schedule S-E Form 1040 if either of the following applies. Your net earnings from self-employment including church employee income were more than $400. So we're typically looking at the Schedule C type of business because when we think about self-employment income, that's the main thing we think about and that's our point of focus, which means you would be filing a Schedule C, which is basically an income statement. If you had income minus expenses on the Schedule C over $400, that would be attributable to you. The IRS basically thinking of you as having like net income similar to W-2 income, but both employee or employee portions allocated to you and then you'd have to file that Schedule S-E for the self-employment tax. You have church employee income of $108.28 or more. That's kind of a funny number. Why do those funny numbers come up? Because they came up a long time in the tax code and they never updated the tax code so they just had this wonky kind of low ball limit and now it looks kind of ridiculous. It's kind of funny to see some of those numbers that come up. They're almost irrelevant like $108.28, really. So in any case, so S-E tax rate, let's do a quick comparison of these numbers to numbers that you might be more familiar with as a W-2 employee. So in other words, the Social Security, if you were a W-2 employee, would be 12.4 divided by 2 or 6.2% because that would be your half as the employee. The employer would be paying, in essence, the other half and the Medicare. You can see here is the 2.9. If I divide that by 2, it's going to be the 1.45. That's how much would be on like your W-2 as kind of a flat tax generally. Remembering that the Social Security does have a cap that if you go over that, you don't pay more than what is on the cap. So it was 1.45 plus 6.2 gives us that times 2, and that's where they're coming up with this 15.3%. So remember, you have a schedule C. The bottom line of the schedule C income minus expenses is what the IRS sees as your wages, in essence. They also see you as both the employee and employer. Therefore, you're paying both the employee and employer portion of self-employment tax, Social Security and Medicare, on the net income. That's the idea. Now, it's not perfectly that amount. The actual form is a little bit different, more complex in the calculation, which we might talk about in a future presentation. So maximum earnings subject to self-employment tax. So only the first 160,200 of your combined wages, tips, and net earnings in 2023 is subject to any combination of the 12.4% Social Security part of the self-employment tax, Social Security tax, or the tier one part of railroad retirement. So in other words, Social Security, we just said the total tax rate is the 15.3%, but it's not that simple because we have to break it out between the 12.4%, which is allocated to Social Security versus the 2.9, allocated to Medicare. Note that the Medicare tax is much smaller and Medicare is more appropriate to me. It seems more correct in that it looks like it's structured more like a safety net program, as opposed to a government-wide retirement program, whereas the 12.4% Social Security is a pretty large amount of tax that is funding everybody that might get benefits from the program instead of having a safety net type of program. So because the Social Security, we're thinking of it now as a retirement program for everyone, like a government 401k program, then there's a cap on it. So in other words, if you pay more, if you have more income than 160,200, you no longer pay any amount above that into Social Security. And that means the Social Security or self-employment tax calculation is a little bit complicated if your amount is above that because you have to break out the Social Security versus the Medicare and then apply the cap to the Social Security. You can see this on W-2s, by the way, if you were an employee in that the wage boxes, box one, three, and five, might differ if you had income over 160,200, box one possibly being higher wages for federal income taxes than box three, which would be capped at 160,200. Why would they do that? Because if you think of it as a retirement program, then if you pay more money into it, you should get more of a benefit out at the point of retirement. But over a certain threshold, you don't get any more benefit because they also think of it as a welfare kind of benefit program where your benefits actually go down as you pay more into the system and after you clear a certain point, you no longer get any more benefit. So that's why there's kind of a cap in there and that's one of the things that people are often going to argue over in terms of tax code. What should be the cap? Should there be a cap? And so on and so forth. So that's the idea with the cap. Now also realize that you could have complex situations meaning if your net income on Schedule C is over 160,200 then you're only going to pay Social Security up to that 160,200. But what if you also had W-2 income and it's applied to the same Social Security number and the combination of the two of them is over 160,000? Why is that complex? Well, because you should only have 160,200 to every Social Security number and the W-2 wages, you only paid 6.2% half your employee half whereas this amount on the Schedule C, you'd be paying twice that because you're paying both the employee and employer portion. So tax software can be helpful with those types of calculations as well. In the case. So all your combined wages, tips and net earnings in 2023 are subject to any combination of the 2.9% Medicare part of self-employment tax, Medicare tax and Medicare part of railroad retirement tax. If wages and tips you receive as an employee are subject to either Social Security tax or the tier one of railroad retirement tax or both and total at least $160,200 due to do not pay the 12.4% Social Security part of the SE tax on any of your net earnings. However, you must pay the 2.9% Medicare part of the SE tax on all your net earnings. So now that's the situation where you have W-2 income that's also subject to self-employment but you're paying only the half versus also having Schedule C income, right? So tip, deduct one half of your SE self-employment tax as an adjustment to income on line 15. So here's another one that we will see this will become more clear when we get to the tax software, tax software helps with these calculations but it's useful to compare this concept to the similar situation in a Schedule C business where the Schedule C is a separate legal entity paying taxes on the business or corporate level. If you were a Schedule C business, everybody that works for it highest executives are still going to get that W-2 and they are going to pay their half of the self-employment tax as far as a deduction for the Schedule C that will be shown as wages, right? It'll be part of their wages which they paid but we as the corporation had to actually take it out of their check and pay it to the government on their behalf. We still get to deduct the whole thing as wages. Then we have to pay as the corporation our half of the self-employment tax as well but we at least get a deduction for that. We deduct that as payroll tax expense. So if we're on our side now we're saying well what happens on the Schedule C if you're saying that the net income on the Schedule C income minus expenses is subject to both employer and employee taxes then I should get a deduction for the employer part of the taxes just like because you're trying to mirror the same thing that would happen on a separate entity like a Schedule C. So it's like okay that makes sense so they're going to let you deduct that but I can't deduct it on the Schedule C because I had to calculate income minus expenses to get to net income to then calculate what the tax was in the first place. Therefore that half of the self-employment tax is an above the line deduction or adjustment to income deduction on the Schedule 1. So we'll see that later. Additional Medicare tax. So there's a 0.9% additional Medicare tax may apply to you if your net earnings from self-employment exceed one of the following threshold amounts based on your filing status. So Medicare seems more like a safety net type of program to help people that need it whereas Social Security seems like it's leaning more towards a federal government funded retirement program. And so the Medicare so that means the Social Security we saw had a cap you no longer pay into it whereas the Medicare actually goes up as your income goes up. You might have to pay another 0.9% additional Medicare tax which is like another layer of a typical progressive tax kind of move on that one. So married filing jointly if it's over 250,000 so this of course now it's a progressive tax. This kind of makes sense because it's a safety net program but anytime you add a progressive level to the tax it does greatly complicate the tax calculation and planning situation. So married filing jointly 250,000 married filing separately 125,000 single head of household or qualifying surviving spouse 200,000 so tax software can of course help greatly in those calculations. So if you have both wages and self-employment income the threshold amount for applying the additional Medicare tax on the self-employment income is reduced but not below zero by the amount of wages subject to additional Medicare tax use form 8959 additional Medicare tax to figure this tax. So again if the Schedule C is your only source of income then you can apply this rule it's fairly straightforward but if you had W-2 income where you're also paying into Social Security and Medicare and you have a Schedule C business then you can see how these kind of caps and progressive systems will get a little bit more complicated because you're calculating them on two different areas and applying two different methods for the W-2 payroll tax versus the self-employment tax. Alright, so here's a table. So which form must I file? So if you are liable for income tax then use the 1040 or 1040 SR the Schedule C do the Dubai 15th of the fourth month after end of tax year self-employment tax then use the Schedule SE which will be attached to the form 1040. File with the form 1040, 1040 SR or 1040 SS. Estimated tax payment, those are your estimated payments you've got to make basically quarterly. That's called the 1040 ES which is basically just a payment stub that's not the 1040 form. Dubai the 15th day of fourth, sixth and ninth months of tax year and 15th day of the first month after the end of the tax year because you have it basically on a quarterly basis or the month after each quarter that means that the last payment you would think would be due in the first month of the following year. Social security and Medicare taxes and income tax withholding this is the 941, 944. This is a different form than we're focused in on here if you're a Schedule C employee business you might also have Employees in which case you have to deal with payroll taxes in which case you have to deal with their social security and Medicare and your half of paying related to their social security and Medicare but the net income that you have will still be subject to possibly the self-employment tax. Payroll is a whole different thing but it has similar rules across different types of entities and so those are due on a quarterly basis on April 30th, July 31st, October 31st and January 31st providing information on social security and Medicare taxes and income tax withholding that's the W-2s, W-2s and W-3s if you're sole proprietor business and you have Employees then you're the one that's responsible for withholding their money, paying it on their behalf to the government as well as your portion to the government and reporting the W-2s and W-3s not only to the employees but to the government by January 31st federal unemployment tax otherwise known as FUTA that's going to be a 940, that's another payroll tax situation so if you have employees you're going to be subject to the FUTA tax and that is usually filed on a yearly basis April 31st typically, April 30th, April 31st October 31st, January 31st but only if the liability for unpaid tax is more than 500 usually FUTA tax is a lot smaller amount of tax filing information returns for payments to non-employees and transactions with other persons see more information that's like your 1099s so you have people working for you not as an employee but rather as a contractor you have to then file or process not a W-2 for them possibly but rather the 1099 giving it to not only them but the IRS so the IRS can go after them for the money you gave them because to them it's income in the IRS's eyes so to the recipient January 31st and the IRS by February 28th other forms see the general instructions and then the excise tax if applicable you can see the instructions for excise tax as well